June 19, 2013

New Altman Weil survey reveals law firm leaders understand the problem, but not the solution (Part 2 of 2)

The 2013 Law Firms in Transition Survey also showed signs of a stubborn underlying optimism that things are
getting better, at a time when the objective evidence says otherwise. For example, when the survey asked “Do you
expect your firm’s effective (realized) rate for 2013 to be up or down?” 67%
said up, 9% said down and 24% predicted no change. Of course we will have to wait to find out
what actually happens by the end of this year, but we do know that in the past
the managing partners and chairs who participated in this survey have been
wrong on this question every time this survey has previously been conducted.

In each of the preceding four
years, the majority of participants (ranging from 59% to 72%) have predicted
realization would go up. However,
according to the 2013 Report on the State of the Legal Market from
Georgetown Law and Thomson Reuters, in each of those years realization actually
“continued to decline, reaching historic lows” (p. 5), currently 83.6%.

Law firm leaders also seem stubbornly fixated on yesterday’s
tactics. 89% said they plan to pursue
growth by acquiring laterals, making this the number one approach to
growth. But according to the Hildebrandt
Citi Private Bank 2013 Client Advisory (p. 11), “Many firms have been
disappointed with their lateral return on investment.” In that study, 40% rated their laterals as either
break-even or downright unsuccessful.

More importantly, focusing on laterals feels completely out of
synch with the way that the marketplace is changing. In Altman Weil’s most recent Chief Legal
Officer Survey, the top three things clients would “most like to see from
your outside counsel” were greater cost reduction (59%), more efficient project
management (53%) and non-hourly based pricing structures (53%). Senior management should be spending its time
trying to deliver what clients want, not engaging in bidding wars for
rainmakers whose business may or may not follow them to their new firms.

What are law firms doing to respond to client demands? According to the Law Firms in Transition Survey,
their “primary response to pricing pressure appears to be discounts.” When “we
asked leaders what percentage of their firm’s fees came from discounted rates,
the median response was 21% to 30% of fees in all firms and 31% to 40% of fees
in firms with 250 or more lawyers.” (p. iv)

And the most widely accepted change to the business model has
been to reduce overhead, as many a laid off law firm former employee can tell
you. 65% of firms have already changed
their approach to managing overhead, and another 30% are currently considering
it.

Both of these changes may be necessary, but as primary
strategies they are misguided in several ways. Discounting does
more damage than cost cutting can easily repair. A 1% reduction in revenue requires more than
a 1% reduction in costs because it affects partner profits as well as
overhead. The exact multipliers depend
on a number of variables, as explained in my book Legal Project Management,
Pricing, and Alternative Fee Arrangements.
For an example of how the math works for one small firm see the post Discounting,
realization, profitability, and legal project management, Part 3in this blog. In that case every
one percent loss in revenue due to discounting led to a 3% loss in partner
profits, while each one percent reduction in costs led to recovering only 2% of
partner profits.

Well if laterals are not the answer, and cutting overhead is
not the answer, what should law firm leaders be doing? There are no silver bullets or magic
solutions, but they would do well to start by putting more of their time into listening
to clients, and giving them what they want. Success in any business is based on
only one thing: meeting client needs in
a sustainable way. In the current
environment, that will require many firms to focus on legal project management. To address pricing pressure, for example,
firm leaders should be thinking not about cheaper discounted hours but rather learning
how to meet client needs at the same quality with fewer more efficient hours

As Tom Clay summed up the survey:

Law firms need to cultivate the
opportunities in today’s changing legal market, rather than hunkering down
against the threats. This is a difficult lesson for an inherently cautious
profession, but it must be learned.